My own view is even more pessimistic. On balance, I think macroeconomics has gone backwards since the discovery of the Phillips curve in 1958 [1][2]. The subsequent 50+ years has been a history of mistakes, overcorrection and partial countercorrections. To be sure, quite a lot has been learned, but as far as policy is concerned, even more has been forgotten. The result is that lots of economists are now making claims that would have been considered absurd, even by pre-Keynesian economists like Irving Fisher.

Phillips showed that there was a negative correlation between unemployment and inflation, a finding replicated for the US by Samuelson and Solow. The result was consistent with the then-dominant (Old) Keynesian models which taught that inflation (or deflation) arose in situations of excess (inadequate) aggregate demand and therefore low (or high) unemployment.

The first mistakes in interpreting the result were made by Keynesians, notably including Samuelson and Solow. Although their journal articles included lots of qualifications about expectations effects, these qualifications were downplayed in policy discussions, leading to the idea that policymakers had a menu of choices. In particular, appropriate use of fiscal and monetary policy could permanently reduce unemployment at the cost of somewhat higher inflation. This claim went along with the widespread belief that macroeconomics was now, for policy purposes, an exact science, which would allow “fine tuning” of the economy, in the unfortunate phrasing of Walter Heller, Kennedy’s head of the Council of Economic Advisers.

Taken together, the “menu” interpretation of the Phillips curve and the belief in fine tuning imparted an inflationary basis to policy, which was already evident by the time Milton Friedman gave his 1968 Presidential Address to the American Economic Association. Friedman argued that the trade-off in the Phillips curve was only temporary. Once firms and workers got used to higher inflation, they would build it into their expectations, and the initial reductions in unemployment would be lost. Friedman also argued against fine-tuning, pointing out the “long and variable lags” that made short-term fine-tuning impossible.

Friedman’s criticisms were broadly correct, and were validated by the inflationary explosion that began around the time of his address, but he pushed the point too far in several respects. First, at inflation rates near zero, there really is a trade-off, arising from the fact that interest rates can’t be negative. This point was implicit in Keynes’ discussion of the liquidity trap, but was reinforced by Krugman’s analysis of the Japanese experience in the 1990s, and is highly relevant today. Second, he took his critique of the Phillips curve to mean that there was a “natural rate” of unemployment, determined by labour market conditions (this is now usually called the NAIRU or non-accelerating inflation rate of unemployment). It’s turned out that long-periods of high unemployment have their own self-sustaining effects – Olivier Blanchard and Larry Summers christened this “hysteresis”. So, estimates of the natural rate tend to rise when unemployment is high, making the concept virtually useless as a guide to policy.

Third, Friedman used his critique of fine-tuning that macro policy should be confined to a rules-based monetary policy, with no role for fiscal policy. Although Friedman’s own prescription (a rule controlling the rate of growth of the money supply) was unsuccessful and quickly abandoned, these ideas were the basis of the policy regime, based on the use of interest rates as an instrument to meet inflation targets, that prevailed from the 1980s to the financial crisis, and to which central banks plan to return as soon as the crisis is over.

The real decline was in the 1970s and 1980s, as Friedman’s already overstated critique of Keynesianism was pushed to the limits of credibility and beyond. The big ideas of the period: Ricardian equivalence, Rational Expectations, Policy Ineffectiveness, Microfoundations, Real Business Cycle theory and the (strong-form) Efficient Markets Hypothesis were based on plausible (to economists, anyway) arguments. They didn’t have much empirical support but, given that Keynesian models weren’t working well either, this wasn’t enough to stop them taking over the debate.

The main response was New Keynesianism which showed that with plausible tweaks to the standard micro assumptions, some Keynesian results were still valid, at least in the short run. New Keynesianism gave a rationale for the countercyclical monetary policies pursued by central banks in the inflation targeting era, whereas the classical view implied that a purely passive policy, such as Friedman’s money supply growth rule, was superior. Broadly speaking the pre-crisis consensus consisted of New Keynesians accepting the classical position in the long run, and most of Friedman’s views on short-term macro issues, and abandoning advocacy of fiscal policy, while the New Classicals acquiesced in moderately active short-term monetary policy

How you evaluate this consensus depends on your view of the period from 1990 to the crisis. Noah Smith, quoting Simon Wren-Lewis says

macro did produce a policy consensus (basically interest rate targeting by the Fed, with a Taylor Rule type objective function balancing growth stability and price stability), and yes, that policy consensus did help the world, by giving us the Great Moderation, which wasn’t perfect but was better than what came before

Implicit in this view is the idea that the Great Moderation was a policy success and that the subsequent Great Recession was the result of unrelated failures in financial market regulation. My view is that the two can’t be separated. In the absence of tight financial repression, asset price bubbles are regularly and predictably[3] associated with low and stable inflation. Central banks considered and rejected the idea of using interest-rate policies to burst bubbles, and the policy framework of the Great Moderation was inconsistent with financial repression, so the same policies that gave us the moderation caused the recession.

To sum up, work done in macroeconomics since the discovery of the Phillips curve has offered an improved understanding of a wide range of issues. On the other hand, it has produced and sustained the dominance, in central banks and in much of the economics profession, of an empirically unsupportable position that is resolutely opposed to fiscal stimulus, or to any large-scale countercyclical policy. It has also diverted most of the intellectual energy of academic macroeconomists into a largely fruitless search for microfoundations, at the expense of an improved understanding of the various co-ordination failures that are at the heart of the macroeconomic problem.

I don’t suggest throwing out everything that’s been done since 1958 and starting all over from there. But, in many ways, that would be a better choice than continuing on the current path.

fn1. Phillips himself might agree. He is supposed to have remarked “If I’d known what they were going with the curve, I never would have drawn it”.

fn2. Macro covers a range of topics. In some other areas often classed as part of macro, such as growth theory and national accounting, progress has continued. And macro in 1958 was focused on the case of fixed exchange rates and limited capital flows. Mundell and Fleming in 1963 did the basic work on open-economy macro with floating rates and free capital movements.

I suggest that anyone who wishes to understand the true implications of the Phillips curve should read ‘AWH Phillips: Collected works in Contemporary Perspective’ (edited by Leeson , Cambridge University Press 2000.) with special attention to Phillips work on cybernetics (as they were then called) and economic stability. For a somewhat more tongue in cheek article, I would refer you to ‘Cloudy with a chance of Default’ at http://somewhatlogically.com/?p=785 with specific reference to the quote from Phillips:
“AWH Phillips, of Phillips Curve and Moniac hydromechanical simulator fame, proposed that a similar effort might be made in the study of economics. Realize that he had done much pioneering work on analog simulators and economic stability in the 50’s when the results were shown on an oscilloscope!

Phillips proposed that future developments might enable the construction of an electronic analog machine that “using a combination of econometric and trial-and-error methods, the system of relationships, the form of time lags and values of parameters of the analog might be adjusted to produce as good a ‘fit’ as possible to historical time series, and the resulting system used in making economic forecasts and formulating policies. This would be a very ambitious project. Apart from the engineering problems involved, requiring close coordination of statistical, theoretical and historical studies in economics…” The engineering problems have been overcome with the development of massive computational capability, and the history of climate modeling provides a direct parallel in the study of global warming, an even larger problem than economic stability. “
The main point seems to me that an almost deliberate misinterpretation of Phillips work has been used in an attempt to discredit Keynesian theory. Incidentally, the Phillips curve first appears in his papers on “Stability in a Closed Economy” Economics Journal, 67, 1957, pp. 265-77 For a general look at attempts at simulation (vs. mathematical modeling), please see the link, http://oecdinsights.org/2012/06/27/going-with-the-flow-can-analog-simulations-make-economics-an-experimental-science/

I read around the post-war inflation literature when I was doing my dissertation, and I was surprised to find just how different it was from what I had been led to expect about ‘Keynesian’ inflation theory – i.e., that it was all about the Phillips curve. As you say, Phillips’ paper itself wasn’t published until 1958, and it wasn’t until Lipsey and Samuelson & Solow in 1960 that it was put as a theory rather than an empirical regularity. And it wasn’t until still later in the decade that it became ubiquitous. If you look at the long survey paper on inflation theory by Bronfenbrenner and Holzman in the American Economic Review in 1963, the Phillips curve takes up maybe 3-4 out of 70 pages. That means the Phillips curve was hardly established before it started being ‘expectations-augmented’ Friedman/Phelps style from 1968.

Prior to the PC, and coexisting with it, were a number of other approaches to inflation. There were plenty of ways of talking about a tension between full employment and price stability without taking the PC step of a menu – it was one of the great themes of 1950s macro, especially in practical policy-making circles. There was much scepticism about the idea of a stable trade-off – from Phillips himself, as you say, and I think in Samuelson & Solow (1960) itself – they explicitly warn about its instability. (When Phillips came to Australia soon after the publication of his 1958 paper, he did a new curve based on Australian data, and was met with a lot of scepticism from Australian economists, who pointed out the importance of the arbitration court in setting wages and the major impact of large fluctuations in international commodities prices on Australian incomes.)

One thing that strikes me about the 1950s literature is that it was still common to conceptualise it in terms of shifts in the equilibrium price level rather than an equilibrium rate of inflation – which is one of the things that made PC models novel. There was plenty of discussion about the possibility of inflationary momentum and acceleration before Friedman, even in the 1950s, though this was often blamed on wage and price setting catching up with past inflation rather than anticipating future inflation. It wasn’t that economists pre-1968 ignored the possibility, but that econometric estimations in fact found little influence of past inflation on present inflation (via expectations or otherwise), so it could be dropped from the model in favour of the typical PC relationship between present unemployment and present inflation. Expectations-augmentation alone doesn’t explain why inflation took off in the 1970s – within the NAIRU/natural-rate paradigm, it seems that the NAIRU itself must have shifted substantially in countries like the UK or Australia, where around-2-percent unemployment had been for many years consistent with very modest inflation.

Finally, it is interesting that the idea of a Phillips-curve-style trade-off had a different political colouring in different countries. In the US it was associated with liberalism, with Samuelson & Solow as Presidential advisers, because US unemployment was relatively high and the PC was deployed to suggest it could come down. Whereas in the UK and Australia, with low unemployment, it was associated with conservatism and the idea that full employment was unsustainable.

I especially like the nod to financial repression. I suspect this is a major direction realistic policy-oriented macroeconomics is going to go in — that if you want central banks to be responsible for stabilization policy, it’s not enough for them to set the short-term risk-free rate, they need to also control interest rate spreads and the composition of lending, implying. a much more comprehensive set of controls on credit markets.

Under the current regime, the interest rate corresponding to full employment may well be too low for financial stability. (“John Bull can stand many things, but he cannot stand two percent.”) Of course the other way to resolve this contradiction is simply to give up on full employment, and conclude that the only problem with rule by central banks — I also like how clear the OP is that this is the content of the pre -2007 liberal consensus — is that they have been too lenient, keep interests rates “far too low for far too long.” This is the conclusion of e.g. Claudio Borio’s recent BIS working paper. I sketch out some criticisms of this view here, but fundamentally whether it is accepted probably depends on whether chronically higher unemployment is politically sustainable. If it’s not — if we have two, three, many Occupies — then I think a policy turn toward financial repression is almost inevitable.

“My suggestion is to push it lower in two stages. First, test the waters by cutting the interest on excess reserves (in Fedspeak, the “IOER”) to zero. Then, if nothing goes wrong, drop it to, say, minus-25 basis points—that is, charge banks a fee for holding their money at the Fed.”

1) Why are we expected to endorse that the Great Moderation, even sans the subsequent fall, was a consummation devoutly to be wished? It featured lower average GDP and especially real wage growth than the preceding 30-year period. If you have to choose between higher but less stable growth and lower growth with smaller fluctuations, how is it rational to prefer the latter, at least within the parameters we are talking about? The benefits of growth are cumulative, whereas those of “steadiness” are not, at least not directly. The faster growing society will eventually be wealthier even in its troughs than the other is at its peaks. Further, isn’t higher growth what conservative economic actually promised, and lack of fluctuation a goalpost move that occurred after the ball had landed? Perhaps, I’m wrong on this, but I haven’t seen anyone, including you in your book, actually state this or point to articles circa 1980 advocating neoclassical policy as a way to slower but more stable growth and claim that this is desirable. Further, Schumpeter fans would seem to dislike this tradeoff as an encouragement of innovation.

2) Why is the appreciation of asset prices, at least in P/E terms, not inflation like other prices? If we simply stipulate strong EMH – that these prices must accurately reflect discounted future value, as least as well as anything can – I suppose we could say that the apparent inflation measured by current P/E ratios is an illusion, but if that were true, how could there be asset bubbles? If we don’t stipulate that, should not asset inflation be part of what we measure when we measure inflation? In fact, given the liquidity of stock in particular, should not what I am purchasing be considered a claim on short-term earnings, rather than some long run to which I am not committing anyway?

3) If asset inflation is inflation, how much was inflation actually tamed in the 80s and 90s, and how much simply redirected from consumer goods to assets?

I loved the post, it clarified some things, others I knew, and I agree, sounds consistent with everything I think.

But I wonder if you are using the Keynesian classification in the broadest sense, including the likes of Hicks, Samuelson, and even on perhaps to Krugman, or in the extremely narrow sense of Keynes’ own works, and is the distinction interesting?

Some claim it makes a big difference, that the true Keynesian theory–which I always thought was more of a basic framework and orientation, not a modeling method, but I should really crack the actual book one day–does not lend itself to the kinds of modeling used by Keynes’ followers, including all kinds of equilibrium modeling. Or at least, only a few have figured out ways to do so, and the Hicks IS-LM and perhaps the DSGE being two of them, but both of those being fundamentally flawed. But the larger point being that the assumptions made to permit equilibrium modeling are so outrageous that it’s not surprising their results have little empirical support…and equilibrium modeling itself is fundamentally the wrong approach to study an evolving thing like an economy, true dynamic modeling being the correct approach, and true dynamic modeling is also consistent with Keynes, even more than equilibrium modeling actually. Or at least that’s how I understand the argument or several of them.

“Special-purpose banks would probably not be viable for small accounts or if interest rates are only slightly below zero, say -25 or -50 basis points (because break-even account fees are likely to be larger), but might start to become attractive if rates go much lower.”

Ponce, seems to me if you charge banks for holding excess reserves at the Fed, they’ll hold them somewhere else – but if nothing’s appealing that could be a cash stockpile. I don’t see where that either accomplishes much or says much about economic theory. The Fed could generate negative real interest, of course, by generating more inflation and not letting its interest rate on reserves rise. That should kick out the extra reserves.

Martin, here in America, bank deposits are insured by the government. Cash piles in your closet are not. And we have quite a few burglaries. And as I pointed out above, if your paying someone to guard your cash pile, you are earning a negative return on it.

As for what that says about economic theory, the (questionable) belief that interest rates can’t drop below zero seems to undergird several economic theories including some in the OP.

An excellent post. But isn’t “expectations” part of DSGE? There is no need to defend Samuelson and Solow by pointing out that “their journal articles included lots of qualifications about expectations”.

What is necessary is to discredit Friedman 1968 — in other words, to provide a better explanation than “expectations” for why the Phillips Curve shifted away from the origin and how we ended up with higher inflation and higher unemployment, both.

One appealing alternative is to return to the view that cost-push forces can and do drive inflation. Appealing, because it is a view from the time before DSGE. Let me try to open a door.

Other than the misguided and relatively brief retrenchment around 37 FDR ran inflationary policies in the face of deflation for his entire Presidency. WW2 was highly inflationary, though partially contained by direct price controls. After that we went Keynesian with mildly inflationary policy for decades. Why did it take until 68 for people to notice that there was inflationary policy about and make adjustments, especially given that it was not exactly a secret? This narrative must be missing something.

Ponce, I thought we were talking about reserves held at the Fed. I was responding specifically to comment 14. Those are not FDIC insured, but, of course, the Fed is responsible for them, which is even better because the Fed can print money and the FDIC cannot. However, I think commercial banks are capable of better physical security than I am in my closet, not that we are mostly talking about material currency here.

In any case, the fact that it may be possible and desirable to take a minor loss on your money to make its possession more secure doesn’t seem to me to get at the policy issue – if interest rates are close to zero, can you stimulate the economy by lowering them? Is your plan is to get banks to lend rather than hoard money by hiring hoards of Bonnies and Clydes to reduce the physical security for banks of hoarding money, and therefore make them willing to pay to store it securely?

Ciaran, nobody denies that real interest rates can be negative. Negative nominal rates are unusual and it probably requires some sort of capital controls to push nominal interest rates below -2%. As an example of how that can be done, in the 1970s, Germany and Switzerland imposed negative rates on deposits held by non-residents. But they didn’t impose them on residents and it’s hard to see how they could have. The zero lower bound (or at least the vicinity-of-zero-lower-bound) is a meaningful constraint on conventional monetary policy, as opposed to promises of future inflation and suchlike.

In 1958, almost all wages were paid with cash (officially issued paper and metal currency) but by 1978, almost all was paid by the transfer of credit with privately-owned banks. At some stage in between, bank credit usurped official currency as the predominant medium of exchange. Since then everything has gone pear-shaped as banks first created too much money and then too little. Somehow, we should get back to the scenario of 1958 so that governments can issue just the appropriate quantity of new money and, thereby, enjoy the benefit of seigniorage so that they no longer need to borrow. That will not be with paper and metal currency but with digital cash. The UK nearly got there with the development of the National Giro in the 1970’s but, alas, ………..

3) If asset inflation is inflation, how much was inflation actually tamed in the 80s and 90s, and how much simply redirected from consumer goods to assets?

Right, this is exactly what the Borio piece I linked above argues.

The thing is, unemployment was not especially low in the past three decades and wage growth was almost nonexistent. So if you say that asset bubbles show that policy was too loose on average, you are arguing that unemployment should have been even higher and wages should have fallen.

Rather than trying to construct a single measure of inflation, it would seem better to recognize that the interest rate consistent with asset price stability will not in general be the same as the interest rate consistent with full employment and a stable wage share. What we’ve actually gotten is interest rates too low for the former, but too high for the latter. The only solution is to give up on the idea that macroeconomic stabilization can be limited to administering a single price (the overnight interest rate), as the current New Keynesian consensus believes.

I don’t have the time to read closely all the posts and comments in this series (start of term) and so won’t even try to contribute, but let me just say both the posts and comments look incredibly clarifying for me – thanks.

I think the discussion of macroeconomics suffers mightily from being stuck in analytic a priori modeling, when we should be building operational models in our heads. Too often, U.S. macroeconomists talk about targeting interest rates, in the abstract, when, concretely, in most of the post-WWII period in the U.S. that has meant targeting housing (and autos).

We re-write history to feature Friedman lecturing on the natural rate of unemployment and inflationary bias, when Nixon, oil, hitting the global resource ceiling in 1973, and floating exchange rates might have had something to do with it. I look at the instability of the 1970s, and I see an impasse on income distribution, which is resolved, as we know, decisively, in favor of capital.

It seems to me that a policy of asset inflation had a lot to do, initially, with the decision to import oil and to pay for it with financial paper, instead of manufactured goods, creating a need to recycle petrodollars, and a knock-on requirement — if we were not going to simply sell the whole country to oil sultans — to inflate U.S. asset prices.

The misplaced abstraction, which “explains” macro as disembodied interest rate targeting has a correspondence in the fetish for explaining international trade and exchange rates with “price level” (as if there even could be such a thing!). (I admired Josh’s post on his own blog taking Krugman to task for endorsing the idea that the European peripheral countries were being put under deflationary pressure to adjust trade goods prices toward “balance”.)

The U.S. has been “supplying” a money (not money, “a money” — nominally zero-risk debt securities) to finance the development of China. We talk about the “housing bubble” as if it were some psychological curiosity, like Tulip Mania, with no apparent understanding of how it related to the need of China for U.S. treasuries, a need that was supplied by mortgage-backed securities. (And, the loop back from investment in manufacturing in China that left the Great Lakes a Rust Bowl, while Manhatten glistened?)

It may be that it is politically impossible to speak plainly about policy in a country that still has at least the form of democratic governance, and to do policy of the sort pushed by the neoliberals. That alone would seem to be reason enough to try to speak plainly and concretely.

Solow and the Phillips Curve was bad. Solow’s growth model was also bad, really bad, but macro kept the Solow growth model. It might be wise to revisit that. (Of course, I hate disaggregate production functions, and I really, really hate the stupidity of an aggregate production function. ymmv)

In the 1960s, Davidson, Kaldor, Kalecki, Robinson, and Weintraub were all mainstream macroeconomists. Economics went bad when economists at, say, MIT and Yale starting ignoring these economists and taking seriously economists following on Friedman and Lucas. (Robinson did help forwarding her brand of economics at Cambridge by feuding with Kaldor.)

These are sociological observations. Why economics took this turn might have something to do with Bruce Wilder’s observations in 33.

bloggers in general, and perhaps at CT, often like to complain that the mainstream media will cherry pick among opinons and experts, often showcasing inflammatory views that represent a tiny minority of experts

It seems to me that a policy of asset inflation had a lot to do, initially, with the decision to import oil and to pay for it with financial paper, instead of manufactured goods, creating a need to recycle petrodollars, and a knock-on requirement — if we were not going to simply sell the whole country to oil sultans — to inflate U.S. asset prices.

I do not see asset inflation as the policy used to avoid selling the US to the sultans instead of just exporting manufactured goods. It was actually the surplus countries that decided how many goods they needed to import and ended up with a surplus that needed to be invested. A deal was reached: the US would recycle petrodollars and by doing so, would strengthen its financial institutions and dollar hegemony. The result was a public debt bubble in Latin America, default, and neoliberalism.

the need of China for U.S. treasuries, a need that was supplied by mortgage-backed securities.

The US seems the victim here. China does not need specifically US Treasuries but global financial institutions for its development, which the US will not liberate no matter how much dollar hegemony is decried.

The policy is continued control of the global banking and financial institutions. To do so, the US needs to maintain its good credit rating which requires GDP growth which can be achieved by creating bubbles and not counting them as inflation.

“Rather than trying to construct a single measure of inflation, it would seem better to recognize that the interest rate consistent with asset price stability will not in general be the same as the interest rate consistent with full employment and a stable wage share. “

ISTM, a single measure of inflation is a good idea, insofar as inflation intended to measure changes in the value of money. And that measure should include assets, as they are a non-trivial portion of what money is spent to purchase. Cost of living is a somewhat different matter. What you’re saying about the interest rate, though, holds I think only if you believe the interest rate is the philosopher’s stone that can transform all substances, which has been the prevailing notion. I think that is your actual point – not that there is a problem with the concept of inflation, but that juicing the interest rate is insufficient for management. Even there, though, we should note that the transfer of inflation to assets seemed to have something to do with such things as capital gains tax cuts and financial deregulation – policy changes that are not concerned with the interest rate per se.

A piece in Quartz suggested a way to have negative nominal rates. The trick is to have two different values for printed and electronic currency. The printed currency can then be deposited at the Fed for continually smaller values of electronic printing depending on the date of printing. This could depreciate printed currency’s value at a rate that wouldn’t hurt typical uses of printed currency, but would make negative-interest Fed deposits more attractive than hoarding.

And that’s the root of the recession: As Krugman says, money was started to be used as a store of value instead of for its moneyness. Throughout normal times, not just the Great Moderation but all of the postwar period, the monetary base itself was a small part of all dollar-denominated assets.

Also, going back to money as medium of exchange instead of also a store of value does not need something as dramatic as negative nominal rates. We toss around the Zero Lower Bound, but in fact nearly all risk-free assets with maturities over a year yield more than zero. Even at 2%, the 10-year bond has a decent real yield over that time if inflation stays 1-2%. It would take quite the liquidity-trap Keynesian to say the Fed could not lower 10-year bonds to zero if it so choosed.

The typical argument against such action is that somehow lower rates, in and of themselves, create bubbles. So many people, including this post, make the argument that the Fed in the Great Moderation caused the housing bubble with low interest rates. This logic absolutely grates on me for one simple reason: if interest rates were high enough to stop the housing bubble, then they would be high enough to cause much higher unemployment. The fact that spending was mobilized through negative NPV investment can’t be of concern to the central banker. The spending HAS to be mobilized through some conduit, and while consumption and positive NPV investments are ideal, a central bank should not keep interest rates too high and cause high unemployment just to take away the punch bowl.

Instead, we need serious regulatory reform of our shadow banking system which was really the heart of the cause of the bubble and ensuing crisis. Collateralized repos were banking deposits and similar to the pre-Fed panics, there was a run on the banks even though losses on non-subprime ABS’s have been minimal. Most of the real losses were in FDIC bailouts of small banks and very little were from TARP and AIG. Instead of not lowering interest rates to the point allowing proper NGDP growth, the shadow banking system needs to be rergulated, with insurance to prevent panics and very stringent capital and asset quality requirements.

Inflation should not include investment assets because investment is only used as a tool to push back ultimate consumption. Long-dated, durable assets are “consumed” only as they are depreciated and as they need to be repaired. Using an asset price as a proxy for this consumption makes little sense since that unnecessarily brings real interest rates and possible bubbles into the picture.

And keeping the purchasing power of money at somewhat constant path is very beneficial to investors. Real interest rates may go up or go down overtime, but if investors and borrowers know the expected inflation ahead of time, neither will suddenly have more real wealth transferred from them.

It is also false to say that inflation can’t be zero because of the zero-lower-bound. The reason has nothing to do with interest rates at all. NGDP is the real cause of the ills normally attributed to low inflation. Firms do not lay off people because prices are not increasing, but because revenues are not increasing. A lower price but higher revenues per worker keeps lay offs from happening as much as higher prices causing higher revenues per worker.

Finally, as far as “asset inflation” in general, assets do become inflated as real interest rates go down. If inflation and NGDP to up at constant rates, and capital earns a constant percentage of NGDP, lower inflation rates will increase the price of equities and of previously issued fixed-rate bonds. But new buyers of equities or debt actually earn smaller refurns once they sell those equities or the fixed-rate bonds hit maturity. I don’t get the idea that the rentier class does better when real interest rates to down. It’s exactly the opposite over the long-term.

As a policy goal, constant real interest rates seem extremely appealing, especially to those already rich. But that’s incompatible with a goal of NGDP rising fast enough to prevent unemployment. The real interest rate required to achieve that will go up or down based on the appetite for saving. The possibility that it will go down is something that buyers of equities or variable-rate bonds will need to take into account.

Nor does asset inflation = bubbles. Asset inflation from a decrease in interest rates is completely different than appreciation to prices with a negative NPV. That’s on asset buyers to not buy assets with negative NPV, while regulation can help make some markets more efficient than they would be without regulation.

John, adding onto Martin’s comments, there are three things which I believe that I’ve economists rarely discuss about the ‘Great Moderation':

1) OPEC losing a lot of pricing power.
2) Massive suppression of real wage gains for (in the USA) at least half of the labor force, and a decoupling of wages from productivity.
3) The fact that economic growth (in the USA, at least), stank in the Great Moderation, compared to the 50’s, 60’s and 70’s.

May I suggest that you and Gordon are both correct? Two good analyses, imho. Seems like things slowly went awry with the misuse of the Phillips curve, and the reaction by the late-1970s was (being polite here) less-than-optimal. The latter, made possible by the former, was a greater disaster for the academic field, policymakers, and people.

Firms do not lay off people because prices are not increasing, but because revenues are not increasing.

If a business does well with x number of employees and y amount of revenue one year, why would it have to lay off workers if the next year it has the same revenue? This is particularly true for established businesses with a fairly set clientele operating in mature economies with little or no population growth.

Why do workers, particularly in developed countries where they can lead a dignified life, have to earn more year after year? Neither do I understand the argument that Americans had to go into debt because they always have to consume more even when wages are not going up.

3) The fact that economic growth (in the USA, at least), stank in the Great Moderation, compared to the 50′s, 60′s and 70′s.

More than stinky, I view it as natural since population growth is decelerating and the population is growing older.

The issue is that some workers do become more productive and some workers become less productive. If revenue growth is 5%, then these workers could get raises of 7% and 3%. If it’s zero, the firm still has to give the productive worker a 2% raise to keep them from going to other firms. To keep from having a loss, either the unproductive workers see their wages cut 2% or 2% of them get laid off.

BTW, I’m not sure of the decline in NGDP from peak to trough, but it wasn’t just flat from 2008 to 2009. It was fairly flat 2001 to 2003 which was why that was such a slow recovery, but it actually declined dramatically from 2008 to 2009. You had to either become much more productive or you had a chance of getting laid off.

There were things going on back in the late 60s and forwards from there that had big effects on inflation, money and credit creation and asset prices. The US financed the Vietnam war without tax increases, leading to the creation of a whole lot of money. At the same time, petrodollars were moving out of the US as US oil production fell and imports rose. Remember Eurodollars? That combination looked like setting off the mother of inflation bombs in the US and Europe and almost did – there really was a lot of inflation in the mid-late 70s – so the US crunched markets with interest rate rises. Remember Volcker? That didn’t affect the price of oil, though, which continued to rise (though irregularly and sometimes with backslidings, but the volume of oil exported by the ME and N. Africa rose so much that it swamped price variations and the flow of petrodollars remained large), and so did the stock market, which came to be seen as an inflation hedge. Everybody was obsessing about stagflation in the late 70s, which in hindsight can be seen as that interval between the post-War reconstruction of Europe (finished) and the takeoff of NICs like Korea and China (not yet begun). It was only when the artificial financial and trade barriers around China and Russia fell down and places like Korea, Taiwan, Thailand, Vietnam and later the E. European countries became players that the essentially monetary (in my view) causes of inflation could be ringfenced from consumer prices. That was achieved by globalisation, which forced down wages in US and Europe without requiring either interest rate rises (monetary action) or budgetary surpluses (fiscal action). It was the best of all possible worlds for investors; money creation drove up the prices of assets but globalisation stopped the consumer price indices from rising. So the Great Moderation, which looked so wonderful and provoked the same sorts of responses from economists as the pre-collapse peak of the US stock market in 1929 famously provoked from Fisher. Trouble was, everybody had forgotten about households (which had sort of become surplus to requirements) which now had no money, only credit. So the housing bubble burst, and that triggered the GFC, and so here we all are.

(I was going to fix up the paragraphing and so on, but I think I’ll just leave it in its original somewhat breathless form. Flow of consciousness meets political economy).

I’m not so sure that any macroeconomic theory/model will ever encompass all that, but I suppose there’s no harm in trying, provided everybody understands that it’s more like yet another Star Wars trilogy than anything to do with reality.

By the way, there’s and interesting and relevant post on “Economists’ Imperialism” at Economist’s View (Jan. 4) which readers may want to consider:

I hear you, but I wasn’t asserting negative interest rates across the board. Just trying to ascertain ponce’s willingness to pay for my financial-wealth-holding services. No account fees, no transactions costs, just a fixed proportion of value to me each year to keep that wealth safe.

” Neither do I understand the argument that Americans had to go into debt because they always have to consume more even when wages are not going up.”

Well of course the simple answer is that Americans did not “have to” go into debt. But this returns us to the various points I made in the last thread, about things that could not happen again. The epic transformation in people’s lives occurred between 1850 and 1950 (or if you want to stretch it. between about 1750 and 1985). It was in this period that the TV, the radio, the washing machine, the home computer, the vacuum cleaner, the car, etc etc etc the average house in 1985 is more or less identical to the average house now (the only exception being the increased prevalence of mobile phones and the fact that the home computer now is likely to be networked).

But, once invented these things could not be reinvented Good for consumers…not so good for capitalists. So what was to be done? Two options presented themselves: 1; the deliberate spreading of the ideology of conspicuous consumption via advertising and 2; planned obselescence of consumer problems.

One further problem presented itself. The “golden age of capitalism” (roughly 1945-1967) had been “funded” so to speak, via strong trade unions, leading to rapidly increased consumption power, and the rest of the social democratic-Keynesian framework. But this had led to workers being “uppity” and demanding more gruel….an inevitable consequence of growth given that workers were no longer frightened by unemployment. Therefore the power of organised labour and the social democratic-Keynesian framework would have to be destroyed, high unemployment reintroduced etc. etc. etc. This of course was “Thatcherism”.

But then you have a problem. With declining real wages how are you to sell your products? This had not been a problem in the period 1800-1945 because the products that capitalists were selling really were products people needed (washing machines etc.) and also because overall capitalist economies grew. And it had been assumed that this would always be the case.

But it seems that possibly this is wrong. It seems (and this could be wrong) that capitalist economies grow and grow and grow….and then they stop growing, at least at the same rate. Certainly the only high growth countries at the moment are relatively poor countries that are playing “catch up” to the West. For the last 20 years low or no growth has been the norm for the most advanced Western capitalist economies. And since the internet in the mid 1990s there have been few new products that consumers really need. So consumers can’t afford to pay for new products which in any case they don’t really need. Planned obselescence and the ideology of consumption can take care of the “need” part of the equation but households still can’t afford to buy the products.

The only possible solution: Debt and lots of it. Get consumers into debt and you can now persuade them to buy your products. Also you now have control of them…what we have seen in recent years is a form of neo-Feudalism in which people live their entire lives in debt. essentially controlled by the financial centre of the economy.

The problem is when consumers “max out” on their credit cards and the economy stagnates and that is where we are now.

” Neither do I understand the argument that Americans had to go into debt because they always have to consume more even when wages are not going up.”

Well of course the simple answer is that Americans did not “have to” go into debt. But this returns us to the various points I made in the last thread, about things that could not happen again. The epic transformation in people’s lives occurred between 1850 and 1950 (or if you want to stretch it. between about 1750 and 1985). It was in this period that the TV, the radio, the washing machine, the home computer, the vacuum cleaner, the car, etc etc etc the average house in 1985 is more or less identical to the average house now (the only exception being the increased prevalence of mobile phones and the fact that the home computer now is likely to be networked).

But, once invented these things could not be reinvented Good for consumers…not so good for capitalists. So what was to be done? Two options presented themselves: 1; the deliberate spreading of the ideology of conspicuous consumption via advertising and 2; planned obselescence of consumer problems.

One further problem presented itself. The “golden age of capitalism” (roughly 1945-1967) had been “funded” so to speak, via strong trade unions, leading to rapidly increased consumption power, and the rest of the social democratic-Keynesian framework. But this had led to workers being “uppity” and demanding more gruel….an inevitable consequence of growth given that workers were no longer frightened by unemployment. Therefore the power of organised labour and the social democratic-Keynesian framework would have to be destroyed, high unemployment reintroduced etc. etc. etc. This of course was “Thatcherism”.

But then you have a problem. With declining real wages how are you to sell your products? This had not been a problem in the period 1800-1945 because the products that capitalists were selling really were products people needed (washing machines etc.) and also because overall capitalist economies grew. And it had been assumed that this would always be the case.

But it seems that possibly this is wrong. It seems (and this could be wrong) that capitalist economies grow and grow and grow….and then they stop growing, at least at the same rate. Certainly the only high growth countries at the moment are relatively poor countries that are playing “catch up” to the West. For the last 20 years low or no growth has been the norm for the most advanced Western capitalist economies. And since the internet in the mid 1990s there have been few new products that consumers really need. So consumers can’t afford to pay for new products which in any case they don’t really need. Planned obselescence and the ideology of consumption can take care of the “need” part of the equation but households still can’t afford to buy the products.

The only possible solution: Debt and lots of it. Get consumers into debt and you can now persuade them to buy your products. Also you now have control of them…what we have seen in recent years is a form of neo-Feudalism in which people live their entire lives in debt. essentially controlled by the financial centre of the economy.

The problem is when consumers “max out” on their credit cards and the economy stagnates and that is where we are now.

Matt, assets are not limited to durable assets. Stock and residential real estate seem the largest asset classes and neither has a fixed value that simply depreciates. Indeed, since real estate is fundamentally land (and affixed material) and the largest component of its value is location, and stock does not get worn out, neither of these can be said fundamentally to be consumed by depreciation.

What is inflation intended to measure? The cost of living? Does that definition make sense in the context of monetary policy? After all, technological change can change the cost of living, but is not directly a function of monetary policy. When we say that expanding the money supply causes inflation, we mean that it causes the value of money to fall. What value? Its value relative to the various things for which it is exchanged. But of course the relative values of these various things to one another also change constantly. So it has to mean some average of all of them. Assets are one of the things for which money is exchanged, so they belong in the basket of things used to determine the purchasing power of money. Deliberately excluding bubbles is perverse. Bubbles are rapid increases in price, and how is a definition of inflation that excludes them not ignoring precisely what it is supposed to measure? True, a bubble in some asset does not imply that all other prices are going up, but no change in any price implies that all prices are going up – that is why you need a comprehensive or at least well-distributed sample of the various things money can buy to determine inflation.

Your next paragraph leaps without transition into prescriptions, rather suggesting that your normative positions are mixed into your analysis.

If a business does well with x number of employees and y amount of revenue one year, why would it have to lay off workers if the next year it has the same revenue?

I’ve heard it said (particularly in the high tech industry) that a shareholder demand for unachievable levels of growth can be a real problem. (ie. the company is making a profit, but the profit isn’t growing as fast as the shareholders would like, and so the company is in trouble). This is possibly related to the themes of debt and interest rates not being able to go much below zero. The shareholders loan capital to the company, and expect a certain rate of return on their investment, some of which they’re hoping to get via growth. If they don’t get the rate of return they were hoping for, they’re likely to reinvest their money elsewhere.

the firm still has to give the productive worker a 2% raise to keep them from going to other firms. To keep from having a loss, either the unproductive workers see their wages cut 2% or 2% of them get laid off.

There are very few workers whose productivity can be measured with such preciseness. What exactly would you measure to determine that a doctor, a teacher, or a programer’s productivity went up or down by exactly 2%? How does this fit in with women, ugly, fat, and darker skinned people earning less for the same work? The impact of family and networking? How do workers know that another firm is paying 2% more and that there is an opening? What if it is farther away and people are not as nice?

Firms do not need to grow in order to not lay off workers. They can easily stay the same size.

Alex@66

Productivity growth is a thing. Having noted that, the conclusion that follows is that the alternative to workers getting the benefits of it is capital getting the benefits.

How can the workers in a bakery become more productive? Will someone discover that it is not necessary to knead the dough as long? Will it rise faster? Will it take less time to bake? Once a business determines an efficient way to produce a good given quantity and quality of the product, we cannot assume that it will be made more efficient by 2% the next year. And another 2% the next. And then again. Forever.

Then there are millions of civil servants. When one or a group of them become more productive and do not get a wage increase, no capitalist will receive any benefit from it.

Wages do not need to grow year after year after year.

SusanC@68

I’ve heard it said (particularly in the high tech industry) that a shareholder demand for unachievable levels of growth can be a real problem.

Indeed. Then there was a time when firms that had existed for decades productively fulfilling a need had to grow in order to avoid a hostile takeover. Now, the US has to grow in order to cover ballooning interest payments without decreasing its standard of living too much or cutting military spending. But where will this growth come from? Will agriculture that already relies on a workforce of semi-literate, foreign peasants return to slavery? Will Americans eat more? Will university football coaches earn more? Will algebra teachers get their students to crack more polynomials? What are the growth options for prosperous nations with mature economies and little or no population growth other than bubbles and dodgy statistics?

John Quiggin, nice post and Gordon’s paper is well worth reading (thanks to JW Mason). What a mess it all is! I will venture a guess that we are in a complex system (i.e. an n-compartment model), with all the indeterminism and hysteresis that this would imply. As if that were that not bad enough, we have problems with the tools, the rules, and the actors. None of them are stable. The tools, i.e. the mathematical models, are always from only one viewpoint: they leave stuff out. We must link them together in a computer simulation, to try to include more stuff. But then the rules interfere: People including economists have prior ideologies. Is unemployment the fault of the worker? Is growth in government bad? Why is private capitalism presumed to be the “end state” of this system? None of these have definitive proofs in the subject of economics. Then we have the economic actors: humans are creative and they are fallible, and sometimes they change their preferences. In addition, lots of them at the top of the ladder are as greedy and corrupt as anyone at the bottom of it, and the last decades have seen most of the incomes growth to in financialization. Meanwhile several big name economists have turned out to be poor intellects, very good at maths and analyses perhaps, but given to justifying their own priors with lots of hubris, and ill-equipped to deal synthetically with their own subject on some topics where it is very important — think of economics’ low priority on the development of “human capital”, for example, or economics’ shoddy interface with natural ecology. I believe that economics is an intellectual victim, because scientific analysis from early modernism cannot quite hit its moving target, which is a complicated condition in late modernism. The way it looks now, we could be watching a shift in the whole system, to deal with the reality of “capital-biased technological change” (somewhat masked, as “career volatility due to globalization” or some such phrase) in addition to demographic aging etc. –Why is this statement any more gibberish than Real Business Cycle theory? It has more to commend it.) The central banks have instituted a permanent regime of very low interest rates, by being so successful in fighting inflation for three decades. So what is “savings”, what is “investment”, what is an “interest rate”? These are instrumental accounting categories, not real things with natural dispositions. Perhaps we are all going to end up working for the central bank, and fiscal government will come to be understood as a massive corporation that provides non-market goods on a regular basis. About a hundred years after that, the world will be entirely socialist, and far more creative than it is now.

At a time when we really need “big picture” economics — however “big picture” critical assessment maps to academic specialties, “macro” or others — we have a spectacular intellectual #fail. We need some profound, synthetic linking together to make sense of the implications of the communications/computing revolution, globalization, climate change and ecological collapse and peak oil, institutional exhaustion at the end of American imperial hegemony, the consequences of latest morphing of corporate capitalism (CEOs paid millions, monopoly capitalism rampant, financialization), et cetera.

The gap between the phenomena we have to build some shared understanding of, to govern ourselves democratically or otherwise, and the vocabulary and frameworks being handed down from on high, and being used daily and visibly by the “serious” politicians and pundits, is yawning wide and deep: an abyss of dreams as vast, it would seem, as the very real problems developing in the shadows of our ignorance and inattention, and threatening human civilization.

A capitalist system without growth would need to obtain capitalist profit internally ie by expropriating workers (of standard of living and leisure) and expropriating smaller capitalists in a blatantly Marxist scenario.

A capitalist system with growth destroys the environment, overpopulates urban and rural centres, and obtains profits through passing problems onto future generations.

Under socialism, normal profits are obtainable internally without expropriating and without needing continually expanding markets and resources. Under socialism growth is represented by higher quality, not more quantity, and some of the quality can appear as more leisure.

A thought that occurs to me reading this thread as a non-economist… formulations of Say’s Law tend to ignore the time-shifting aspect of money: that we sometimes sell goods or services now in order to buy them later, using money as the means of storage. A general glut in the present can be matched by a shortage in the future (or people’s expectation of the future): if everyone wants to exchange things they’re producing now for things they want to consume later, the flows don’t balance and you can’t sell the current production.

And, possibly related: if the total production capacity is declining, and you can’t have negative interest rates because people can just stuff banknotes under the mattress, then inflation seems inevitable: in the future, the same amount of money will be chasing fewer goods. (Unless the government deploys other ways to destroy money, such as burning the money it receives in taxes).

Maybe not difficult to type; difficult to understand or confirm, though. What work is ceteris paribus doing? Where and when in the 300-year history of the modern capitalist economy and industrial revolution has capital reliably gotten an ever-increasing “profit”?

Conventional neoclassical economic theory asserts that, as a market economy approaches equilibrium, economic profit approaches zero. The sunk cost nature of most capital investment in dedicated organization and equipment means that returns to capital are always risky and subject to competitive erosion. So, at least according to its own ideology, profit should, in the long-run, be declining in a “capitalist” system.

So, I remain confused by claims to the contrary, and regarding an alleged essential nature of the beast, to be distinguished for other beasts, such as reified “socialism”.

Money, as currency and in its various extended forms as financial instruments, would seem to be a key explanator for why the macro-economy is not self-stabilizing, without institutions to stabilize it, including institutions to competently manage (a fiat) money.

Why, exactly, economists feel compelled to keep abstracting away from money in analysis of the macro-economy’s functioning is a great puzzlement. Moving on from this simple, basic and seemingly long understood point, though, appears extremely difficult for those tasked to do the moving on.

And, to reinforce your second insight, yes, some rate of positive inflation will characterize any competently managed system of money. It is absolutely necessary to maintain pressure in the system of flows.

Of course the stable core of meaning in capitalism is interest payment on capital. Perhaps the only aspect of capitalism people agree on is that before it the system was called feudalism and that was about 500 years ago. What happened then was the transition from sinful usury to legal interest payment.

Then there is Yanis Varoufakis’ image of capitalism as a hand that stretches into the future to extract capital to be invested and then repaid, with interest, back in the future.

>If interest rates are negative, I’d sit on my money and not lend it to anyone. Not even you.

You owe Fast Eddy $5,000 at 30% interest.. You have have $5000. you can

1. Pay Fast Eddy $125 so as he doesn’t break your legs and put the other $4875 in a negative interest rate account.

2. Pay Fast Eddy $125 so as he doesn’t break your legs and loan $4875 to ponce at 0.5%. If ponce loses it at the races, Fast Eddy will break your legs next month when you can’t pay.

3. Pay Eddy his $5000, for a return on your investment of 30%

That’s why you can’t have negative interest rates. At some point people take their money and pay off debt rather than consume or invest. Low growth means your real productive investments go sour and people park their money elsewhere. If this goes on long enough you end up with a structural investment problem (structural unemployment’s cousin)

“If you have to choose between higher but less stable growth and lower growth with smaller fluctuations, how is it rational to prefer the latter, at least within the parameters we are talking about? The benefits of growth are cumulative, whereas those of “steadiness” are not, at least not directly. The faster growing society will eventually be wealthier even in its troughs than the other is at its peaks.”

It is rational because we care about individuals, not just about aggregates. In practice, the down side of fluctuations see some individuals lose their jobs and possibly have their entire lives blighted. It is known that the state of the economy the year someone enters the job market, say after college graduation, can have very long-lasting effects on their careers. In other words, the losses to those caught on the down side are cumulative. The added benefits to the lucky do not make up for the ill effects on the unlucky.

Even if in some sense they did, reduction of uncertainty has a positive value. People value a certain amount of loss avoidance more than they do a corresponding gain. Tversky and Kahneman established this a long time ago.

Of course, we care about individuals, not just aggregates, but the stability of the Great Moderation relative to the preceding post WW2 period is something that exists only in the aggregate. If we’re going to talk about stability in the life of the average person, we have to acknowledge that the Great Moderation was a period where income inequality increased dramatically, magnifying the consequences of failure, when real median wages stagnated, lessening the consequences of success, when defined-benefit pensions were largely replaced by 401Ks, when a norm of lifelong employment at one company was replaced by a norm of job-switching, which may not show up in the statistics as higher unemployment, but obviously is not greater certainty, when public goods like higher education become both more necessary for economic success and more expensive. The notion that the period from the 80s to the present feature greater economic stability is the life of the average person than the late 40s, 50s, and 60s is absurd.

The numbers were just to show a point. The math has to work, one way or another, for firms with flat revenues. Can the firm just freeze all salaries and hiring? Of course, but more likely for a larger company is some divisions are doing well and others are doing poorly.

This is especially true if you extrapolate the example out to the whole economy. If total income, or NGDP, is kept flat, then a sector doing well and increasing revenue must have a sector with decreasing revenue. If the attrition of the sector is less than the decline in revenue, there must be lay-offs assuming wages are sticky.

Actually, job-switching probably does show up some in the unemployment statistics – The Great Moderation featured higher average unemployment. In fact, I wonder if one measured recessions by absolute employment figures rather than GDP – say we define a recession as a period when unemployment is above 5% – whether the GM actually features either briefer or shallower recessions than before. It is, after all, the period that gave us the phrase “jobless recovery”. I realize that unemployment figures may not be the best measure of a recession either, but if we’re going to hold recessions as a proxy for misery caused by unemployment, they seem rather germane.

Does kind of tell a story, doesn’t it? Worth noting that those are deltas in employment. The Great Moderation also generally had lower baseline employment, so in absolute terms, the picture is even worse.

lupita @54: “Why do workers, particularly in developed countries where they can lead a dignified life, have to earn more year after year? Neither do I understand the argument that Americans had to go into debt because they always have to consume more even when wages are not going up.”

My point was that the situation changed. And as pointed out by Gordon, those gains were being realized, but retained by capital.

Me: ” 3) The fact that economic growth (in the USA, at least), stank in the Great Moderation, compared to the 50′s, 60′s and 70′s.”

lupita @54: ” More than stinky, I view it as natural since population growth is decelerating and the population is growing older.”

At the time, ‘population is growing older.” meant that the distribution was shifting to workers with far more education, and moving into the peak production and earning years of their lives.

“f we’re going to talk about stability in the life of the average person, we have to acknowledge that the Great Moderation was a period where…” followed by a list of things that disrupted peoples’ lives during that period.

“The notion that the period from the 80s to the present feature greater economic stability is the life of the average person than the late 40s, 50s, and 60s is absurd.”

I did not make such a claim. My comment was simply about aggregate stability vs higher growth ceteris paribus. While not perhaps mathematically inevitable, I do think that in fact higher aggregate instability will usually result in greater average instability in the lives of individuals. The list of factors other than aggregate instability that could and did disrupt people’s lives is largely correct but irrelevant.

In other words, gross aggregate fluctuations during the actual Great Moderation would have made the disruptions in the lives of ordinary people even worse than the noted factors actually did make them.

First I should stress how much you have influenced my thought. I am shocked to recall being shocked to find you denouncing new Keynesianism along with the other zombies.
That said, I will shift to criticism.

First I don’t think that the accusation “notably including Samuelson and Solow” is supported by evidence you present here or anywhere. I assume that when you write “these qualifications were downplayed in policy discussions,” you mean “these qualifications were downplayed in [their] policy discussions,” but you really should support that claim with links. Samuelson wrote a weekly column in the recently banished to cyberspace magazine Newsweek so this could be difficult. More generally 60s era Keynesianism can’t be refuted by finding some people who considered themselves Keynesian and said silly things — schools of thought are judged based on the work of their best proponents and not based on nut picking.

I first read about the Phillips curve (in Newsweek by the way) in an article published in 74 or 75 noting that it had ceased to fit the data, so I don’t know anything relevant.

Samuelson and Solow also discussed hysteresis which they called cyclical employment becoming structural. Friedman 1968 is strictly inferior intellectually to Samuelson and Solow 1960 . I’ll just mention here that Blanchard was a very leading New Keynesian advocate of the Keynes in the short run, RBC in the long run compromise. He seems to have decided to ignore his hysteresis paper within two years (Blanchard and Quah identified supply and demand shocks using, among other things, the assumption that unemployment is stationary).

Also, don’t think belief in a Phillips curve caused the increase in US inflation (I stress that my ignorance concerning other countries is even more complete). Arthur Burns, who would know (but might attempt to avoid blame he deserved) said the issue was that Nixon demanded loose monetary policy in 72 to fend off McGovern. I stress again my ignorance, but note that I know of no evidence supporting any claims about Keynesians made by Friedman or Lucas. I am quite sure that they were skilled and unscrupulous polemicists (note the past tense — I think Lucas has lost that skill).

You seem to think something useful was done after “Keynes and the Classics” and before 1958. What do you have in mind (again I stress my ignorance).

@RW I got my start in economics in 1971, from Samuelson’s textbook (Economics, not Foundations, and I certainly acquired the belief in a stable long-run trade-off. I won’t swear to what was actually in the book, but I can say that the “menu” interpretation wasn’t a retrospective invention. Here’s a piece by Robert Gordon who’s a very careful scholar in my experience which is, I think, consistent with what I’ve written. I think it’s fair to say that Samuelson and Solow were a lot more cautious than in commonly supposed, and that the simplistic interpretations owe a fair bit to Heller and others. But Friedman was much clearer on expectations than Samuelson and Solow and right on the central point, so he prevailed on that point and also where he was wrong.

As regards useful stuff between 1937 and 1958, there was a large body of work on the consumption function (mostly displaced, unfortunately in my view, by life-cycle optimization models) , the development of national accounts, the treatment of the open economy case by Salter & Swan, and the development of macroeconometrics.

That’s not exhaustive – I’m sure I could think of more. The main point is that the Keynesian model (in the Hicks IS-LM interpretation) was developed, improved and qualified in a lot of different ways. A lot of that continued after 1958, but it was overshadowed by the larger swings from Phillips curve fine tuning to monetarism to rational expectations to New Keynesianism and then into the morass of DSGE macro.

Jonathan, your comment was explicitly in response to my comment at 15. That comment was in the context of the Great Moderation, and the claim was tied to that context with the phrase “within the parameters we are talking about”,. Therefore, a response from you not cognizant of that context is inapposite at best. If you are not commenting in that context, what are you saying? That instability is bad? A rather banal statement. That higher growth is not worth higher instability? That would depend on how much growth for how much stability, wouldn’t it? Or are you seriously prepared to argue that no increase in the wealth of society is worth the slightest cost in disruption – effectively, the maximal demand for stagnation? If you are not prepared to argue that, then you must specify the tradeoffs. I did that by specifying the context.

The Great Moderation refers to set of claims about the nature of a certain period of recent history and the claimed causes of same. Specifically, it is the claim that the shallowness of brevity of recessions from roughly 1980-2008 was due to various policies taken during that time. These include:

Among others. Not is the least coincidentally, these are also many of the same policies that caused so much disruption in the lives of individuals. So “ceteris parabis” comparisons are absurd, as the putative stability you endorse has the same causes as the instability you seek to rule out of the discussion. Further, the Great Moderation is a claim about recessions as measured by GDP growth. You leaped straight from that to the pain of unemployment. But the Great Moderation did not provide greater stability measured by that variable, as the chart Ponce linked illustrated.

“Central banks considered and rejected the idea of using interest-rate policies to burst bubbles, and the policy framework of the Great Moderation was inconsistent with financial repression, so the same policies that gave us the moderation caused the recession.”

I have a simpler way of looking at this.

JVB’s law:
It is not supportive of economic stability to encourage private actors to take on more debt.

P.S. A corrolory of JVB’s law is that given accounting identities (as identified for instance by MMT advocates) – is that in the presence of persistant trade deficits, it is necessary for governments to run deficits in order to protect private sector balance sheets (although it would be better to avoid persistant trade deficits).

“First, at inflation rates near zero, there really is a trade-off, arising from the fact that interest rates can’t be negative. “

Real interest rates can be, of course. But even nominal interest rates can effectively be negative, if one takes into account the principal not being paid back.

To be simplistic about it, if 25% of a country’s banks go bust in a given year, then a nominal interest rate of 0% is an effective negative interest rate of -25%. In the US the bottom of the depression was in 1932-3, when the most banks went bust – when the effective interest rate was most negative. After, things got better. IMHO, not a coincidence. The error this time around wasn’t a lack of stimulus but interest rates which stayed non-negative, because no government let banks go under and depositors to lose their money.

“The error this time around wasn’t a lack of stimulus but interest rates which stayed non-negative, because no government let banks go under and depositors to lose their money.”

?????

This time was not worse. And a probability of losing your money, is not the same thing as a certainty of losing your money. In the depression the failure of banks encouraged depositors to withdraw their money – which is a beggar thy neighbour strategy because it ensures others WILL lose their money. It didn’t encourage those with money under their mattress to spend it – in fact the reverse.

“This time was not worse.”
Who said it was?
“And a probability of losing your money, is not the same thing as a certainty of losing your money.”
Who said it was?
“In the depression the failure of banks encouraged depositors to withdraw their money – which is a beggar thy neighbour strategy because it ensures others WILL lose their money.”
Negative interest rates require people lose their money.

“It didn’t encourage those with money under their mattress to spend it – in fact the reverse.”
I don’t believe I say that spending was a requirement?

“Why should I not regard you as a crank?”
By all means go ahead. Being regarded as a crank by someone with such poor reading and logical skills is not a negative.